Substance Over Form: The Stanbic Reality

Before I start discussing what is on my mind, the phrase ‘substance over form’ is one of my favourite accounting concepts. I love it. The concept is what I really like, and I apply it to many of my daily activities. Recently, I was going through the financial performance of the banking industry players (the tier-1 banks) and saw an interesting trend. See the table below, please:?

The banking industry has been under significant pressure over the past two to three years due to weak macroeconomic prospects and regulatory pressures. A low-yield environment further exacerbated the woes of the banking sector. The double-whammy of weak income growth and rising operating costs is reflected in the valuation of the banking industry.

Investors, particularly foreign folks, have expressed their disinterest in Nigerian assets due to bottlenecks around foreign exchange policy and interest rate management. Meanwhile, these are the guys that really move the Nigerian financial markets. If foreign investors don’t participate, even our biggest local capital source (i.e., the pension funds) is reluctant to invest. I mean, if they buy and decide to sell later, who will buy from them? ?

Accordingly, the share prices of the banking folks declined significantly over the last three years. To be fair, even the profitability of the banking industry also declined. For context, the most profitable bank in the industry is GTCO with an average RoE of 30% thereabout pre-2019. Today, the Group’s RoE is less than 20%. The figure remains strong but is significantly below historical trends. The trend is also evident in other peers including Zenith, UBA and others. In fact, the entire banking industry experienced a profitability decline. And by implication, their valuations reflected it. GTCO currently trades at a discount to its book value – those familiar with GTCO would tell you that this is a move away from the norm. UBA, Zenith, and Access all trade at steep discounts to their book value. Yes, there are underlying issues, but I believe the valuation discounts are too steep.

In all of these, look at Stanbic IBTC Holdings Plc. A clear outlier among every name there. In spite of the challenges in the banking sector, Stanbic still stands strong, trading at a solid premium to book. Yes, the profitability metrics seem solid (i.e., RoA and RoE). But Zenith and GTCO are not doing badly either. Why are the multiples of Zenith and GTCO relatively lower and Stanbic’s higher? Could Stanbic be overvalued? Or are the two banks undervalued?

Well, maybe, maybe not. And this is where substance over form comes to play. On the surface, Stanbic IBTC is a bank. Or more specifically, it is a financial holding company primarily regulated by the Central Bank of Nigeria. As a holding company, Stanbic has numerous subsidiaries including commercial banking, investment banking pensions, asset management, trustees, and insurance. While the banking subsidiary accounts for most of the Group’s total assets and gross earnings, it is not the core value driver of the bank.

Stanbic is special. And it is special because of its other subsidiaries that are cash cows. Stanbic has the largest AuM in the pension industry with an AuM of about N4trn+, edging closer to N5trn. The second largest PFA is at a distant second. The fundamentals in the pensions industry are very strong. The industry is commonly regarded as one with ‘free money’. This is because the risks are lower, the customer acquisition costs are lower, and the competition is lower (well, until recently). Once the AuM is there, the money flows. The pensions business, in my view, is the underlying core value driver of Stanbic.

The asset management subsidiary of Stanbic is also one of the major value drivers of the Group. With a combined AuM of over N650bn, the asset management subsidiary of the Group is also a market leader…. Clear above the next player. The business model here is similar to pensions, although a little bit more volatile, hence with higher risks.

Then there is the investment banking subsidiary which is also a leading market player in the industry. On an annual basis, the investment banking business captures a significant portion of the deals that happen in the economy.

These three diagonals – pensions, asset management, and investment banking account for nearly 70% of the entire Group’s value, given their growth prospects, industry potentials, and market share. The other banks do not have these competitive advantages or opportunities. Therefore, these factors help to support the valuation of Stanbic IBTC Holdings. There are other variables that work in the favour of the Group as well. Some of them include corporate governance, a clear succession plan, a relationship with Standard Bank, and shareholder structure.

In summary, the substance over form narrative is that while Stanbic may be seen as a bank, the reality is that the profitability and value driver do not come from the banking industry. The majority comes from the three diagonals. That is the substance. When you do a sum-of-the-parts valuation, it becomes even more obvious. While investors focus on other banks from a commercial banking perspective, they view Stanbic IBTC a little bit differently. Perhaps, this could even be one of the reasons why some of the commercial banks are sourcing growth through a HoldCo structure.

This explanation also speaks to how analysts must understand the underlying source of value creation of a company. Before you apply that multiple of comparable peers, understand the business, understand the source of profitability, the risks and the competitive advantage of the business.

Selah